Wednesday, April 23, 2014

The California Court of Appeal, Second District, recently held that the failure to designate a trustee in a deed of trust was irrelevant to the validity of a foreclosure sale, ruling that a substitute trustee appointed prior to the foreclosure by MERS, the beneficiary under the trust deed, was authorized to convey title upon the borrowers' default.

The Court also ruled that: (1) California's statutory nonjudicial foreclosure law does not require the foreclosing party to have a beneficial interest in or physical possession of the promissory note; and (2) Borrowers' claims failed because they failed to allege tender of the amounts due and owing under the loan, a prerequisite to setting aside a foreclosure.

Plaintiffs borrowers ("Borrowers") defaulted on their home loan that was secured by a deed of trust. The deed of trust did not name a trustee, but designated Mortgage Electronic Registration Systems, Inc. ("MERS") as beneficiary, allowing MERS "the right to foreclose and sell the Property, and to take any action required of Lender including, but not limited to, releasing and canceling the [trust deed]."

After the default, MERS appointed a substitute trustee ("Substitute Trustee"), which recorded a notice of default. MERS also assigned its beneficial interest in the trust deed to a mortgage loan servicer ("Servicer"). The Loan Servicer in turn assigned its beneficial interest in the deed of trust to the loan owner ("Loan Owner"), which ultimately purchased Borrowers' property at the ensuing foreclosure sale.

Borrowers later filed a complaint to set aside the foreclosure, seeking actual and punitive damages. Borrowers alleged in part that the foreclosure was improper, as the trust deed failed to name a trustee. Borrowers also sought cancellation of all recorded documents related to the foreclosure. The Loan Servicer, Substitute Trustee and Loan Owner (collectively, "Respondents") demurred and requested that the lower court take judicial notice of certain recorded foreclosure documents, which the lower court granted. Borrowers did not object to the request for judicial notice. Sustaining the demurrer, the trial court allowed Borrowers to amend their complaint.

Following the filing of the first amended complaint, Respondents again demurred and requested that the lower court take judicial notice of the foreclosure documents. For the second time, Borrowers failed to object to the request for judicial notice. Sustaining without leave to amend the demurrers of both Loan Servicer and Substitute Trustee, the trial court dismissed the complaint as to these two parties, concluding that omission of a trustee on a trust deed was "no impediment to enforcement of the Trust Deed. . . ."

In addition, ruling that Loan Owner's purchase of the property was proper and that Borrowers had failed to plead a viable ownership interest in the property, the lower court granted Loan Owner's request for judicial notice and sustained its demurrer with leave to amend. The trial court reasoned that, as the beneficiary under the deed of trust, MERS had the authority to name a substitute trustee and assign its interest to the Loan Servicer despite its lack of any ownership interest under the trust deed. The court noted, moreover, that Borrowers failed to tender or offer to tender the funds still owing on the loan.

In their second amended complaint against Loan Owner, Borrowers again alleged various claims for cancellation of the foreclosure documents and wrongful foreclosure. Loan Owner demurred once more and requested that the court take judicial notice of the same foreclosure documents.

At this point, borrowers objected for the first time to the request for judicial notice. Accordingly, the court overruled the objections and sustained the demurrer without leave to amend.

Noting the issue was one of first impression in California, the Court of Appeal rejected Borrowers' assertion that the failure to designate a trustee in the deed of trust turned the security instrument into a "mortgage" requiring that foreclosure occur only through judicial foreclosure. In so ruling, the appellate court relied on rulings in other jurisdictions to conclude that a valid trust is created notwithstanding the failure to designate a trustee. See, e.g., In re Bisbee, 157 Ariz. 31, 754 P.2d 1135 (1988)(ruling that a trust deed is essentially a mortgage giving a trustee the power to convey upon default and that absence of a valid trustee requires the appointment of a successor trustee to take actions required under the instrument); Mid City Management Corp. v. Loewi Realty Corp., 643 F.2d 386, 388 (5th Cir. 1981)(upholding nonjudicial foreclosure sale held by substitute trustee where trust deed failed to name a trustee).

In addition, observing that Borrowers' mischaracterized the nature of "title" provided by a deed of trust, as opposed to that conveyed by a grant deed, the Appellate Court also pointed out that a trustee under a deed of trust holds merely the right to convey upon a borrower's default but carries no other incidents of ownership of the property.

Turning next to Borrowers' argument that Respondents lacked standing to foreclose because Respondents were not the "holder in due course" of the note, the Court noted that California's nonjudicial foreclosure law does not require that a foreclosing party have a beneficial interest in or physical possession of the note and that under the foreclosure scheme "a trustee, mortgagee, or beneficiary, or any of their authorized agents" may institute foreclosure by recording a notice of default. See Cal Civil Code § 2924(a)(1); Debrunner v. Deutsche Bank Nat'l Trust Co., 204 Cal. App. 4th 433, 440-41 (2012). Accordingly, the Court ruled that the Substitute Trustee had statutory authority to commence foreclosure.

Finally, the Appellate Court also concluded that Borrowers' claims failed because they did not allege tender of the amount due under the loan. Citing the general rule that a debtor must allege tender of the amount of the debt in order to set aside a foreclosure based on irregularities in the sale, the Court noted that Borrowers had failed to allege any facts implicating exceptions to the tender rule, such as invalidity of the underlying debt, counterclaim or set-off against the beneficiary or a void deed of trust.

The Court thus ruled that, in the absence of an allegation of tender or offer of tender, the lower court properly sustained the demurrers without leave to amend.The Court of Appeal affirmed the lower court's rulings in all respects.

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